FX Briefing 2 December 2005

Those who are declared dead live longer: US economy is buzzing
The dollar had a slight relapse at the beginning of the week. The release of data showing that existing home sales had fallen significantly, lifted EUR-USD abruptly on Monday up to 1.19, and caused USD-JPY to slip down to below 118.50. The main reason for this unusually sharp reaction is likely to have been pronounced uncertainty in the face of the imminent publication of numerous important US economic indicators and the impending ECB interest rate rise.

However, the dollar rallied again quickly. A whole series of strong US data contradicted the theory that the US economy was faltering. USDJPY benefited most from this and climbed over the 120 mark. At 120.94 on Friday, it reached the highest rate since April 2003. After the ECB Council meeting, EUR-USD settled at around 1.17. The ECB’s interest rate rise of 25bp to 2.25% had already been priced in by the markets after ECB’s Trichet had explicitly announced it in advance. The weakness of the euro after the actual rate rise could possibly be due to some market participants’ fear that the central bank would take a more aggressive stance with respect to the further course of monetary policy. The movement of the yen probably also had some influence on EUR-USD.

After the latest revision of the US GDP data, observers once again could not believe their eyes: despite new energy price peaks and the effects of the hurricanes, the US economy grew in the third quarter in real terms by an annualized 4.3%, stronger than in all five previous quarters. Inventories were reduced further and net exports fell; final domestic demand rose by 4.7% in Q3, which was again stronger than GDP. Private consumption made the biggest contribution to growth. Despite the increase in car purchases and energy costs, Americans apparently did not cut back on the purchase of other consumer goods at all. The revised figures no longer show any slump in investment activities. Fixed investment rose by 8.6% and was thus just as strong as in the previous quarter. Investment in business equipment increased again by almost 11%. Growth in residential property investment slowed down to 8.4%, which was still pretty good.

Admittedly, the quarterly data conceal a more unfavourable monthly development: towards the end of the quarter, private household spending cooled down somewhat, and the aftermath of the hurricanes was evident in production and on the labour market.

However, the picture is brightening up again. Consumer confidence, which had crumbled after the disaster on the Gulf coast, and which the Fed had also seen as an indicator for growth risks, improved significantly in November. In fact, at 98.9, the Conference Board indicator almost reached the average level of the last 1½ years. Retail sales developed considerably, at least excluding cars, and car sales figures show that business had livened up again in November.

Production, which had been dampened by the hurricanes, is also increasing again, and manufacturing industry polls, as for example the ISM at 58.1, continue to indicate strong expansion. Durable goods orders rose again considerably in October. The rise was partly due to the end of the Boeing strike, but even without this special factor, there is definite evidence of an improvement, and the order component of the ISM suggests that the positive trend could continue. In addition, the demand for capital goods (excluding military and transport goods) picked up substantially in October. The sustained willingness to invest, which can also be observed in the commercial property sector, further completes the favourable picture of the US economy.

The 5.6% decline in existing home sales in October had fuelled concern about the US real estate market at the beginning of the week. But the sales figures for new homes have put things in perspective: they rose by 13% to a new all-time high. Property sales figures are in fact very volatile, which makes individual monthly figures difficult to interpret. In our view, the number of units sold is moving sideways on an extremely high level. The price development as a whole has calmed down, which should be welcomed after the massive increases of the past years. A continued price rise would indicate a bubble and this would be the much bigger macroeconomic risk.

In our opinion, the latest economic indicators confirm the robustness of the US economy. Therefore one should not expect the Fed to stop raising interest rates for the time being. For the moment, the interest rate spread at the short-end will thus continue to develop in America’s favour, although the ECB has also raised interest rates. Therefore we see further upward potential for the US dollar.

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